SAExploration Holdings: A Better Bargain After Q2 2014 Results

Aug.13.14 | About: SAExploration Holdings, (SAEX)

Summary

SAExploration Holdings' management continues to carve a path toward significant revenue and cash flow that's being under-appreciated by investors.

Updated guidance confirms past troubles were one-time events.

Upside now close to 100% after factoring in recent results and current share prices.

Two potential catalysts on the horizon to help unlock significant value for shareholders.

SAExploration Holdings (NASDAQ:SAEX) recently released earnings results for 2Q 2014 (press release) that dramatically affirms my original thesis outlined here.

Management continues to carve a path toward significant revenue and cash flow growth, while maintaining best-in-class execution highlighted by a record 745 consecutive days of operation without serious or lost-time injury or incident.

As the company scales revenues organically, management continues to remain focused on achieving "strategic diversification" - parlance in the seismic mapping business for geographic diversification. Brent Whiteley, the CFO for SAEX, provided commentary in the Question and Answer portion of the 2Q 2014 Earnings Conference Call that indicated SAEX is likely to see contract wins in SE Asia in 2H of 2014. I take this as a sign of tremendous progress, demonstrating management's ability to compete in new markets, scale globally, and ultimately achieve its objective of more efficient asset utilization and a smoother earnings stream.

Financial Highlights from 2Q 2014

  • Revenues improved to $103m, up 143% from $42m, year over year
  • Modified EBITDA* was $13.5m, up 78% from $7.6m in the same quarter last year
  • Modified EBITDA* margin was 13.1%, down from 17.9% in the prior year's quarter
  • TTM Revenue and Modified EBITDA are $308m and $29.8m, respectively
  • SG&A as a percent of revenue was 9.7% versus 14.5% during the same period last year
  • Backlog stood at $265m, down from $283m reported on June 13, 2014 and $322m reported on March 31, 2014

*Management began reporting Adjusted EBITDA instead of Modified EBITDA beginning 2Q 2014. A reconciliation of the cash flow measures was provided in an 8-K released by the company on June 16, 2014. I am continuing to use Modified EBITDA, which does not adjust for major one-time expenses (specifically those incurred in 3Q 2013) and non-cash foreign-exchange gains and losses.

Volatile Margins

The previous four quarters have proved that at the company's current scale and geographic footprint, gross profit margin and EBITDA margin are fairly volatile. The table below shows just how broad of a range is possible.

While this may alarm some investors, I would point out a couple things:

  1. The company utilizes fixed-price contracts for the majority of its work. At its current scale, a single mis-step in execution on a single fixed-price contract can materially impact reported financials for a given quarter. It so happens this was the reason for the smaller gross profit figure reported this quarter. But looking forward this problem resolves itself as the company continues to scale up. In my opinion, it's a temporary phenomena and one that I think obfuscates true cash generating potential of the underlying business. Keep in mind, management still believes it can achieve gross profit margin (ex depreciation) of 30% in the long run.
  2. Management has done a wonderful job keeping SG&A expenses constrained during a significant ramp up in sales demonstrating inherent operating leverage within the business model. I expect this discipline to translate to higher EBITDA margin in the future as company continues growing sales.

Backlog Update

Current backlog sits at $265m as of June 30, 2014. Management is expecting 66%, or $175m of the reported backlog to be converted into revenue in 2H 2014. In the shareholder conference call, Jeff Hastings (Chairman) was optimistic that existing backlog would be improved with further contract wins during the next two quarters. Here's an excerpt of his comments:

As noted in our release, we had a very strong backlog of $265.5 million on June 30, 2014. Despite seasonal effects and lower contracting activities which are customary for the spring season, our current backlog which we expect to continue to add throughout the year should allow us to produce meaningful revenues throughout the balance of 2014. We have a number of bids currently outstanding, a handful of which we have a strong level of confidence that we will secure. Some of these expected project awards will complement the 66% of our current backlog we expect to realize during the third and fourth quarters.

So not only should investors expect the typical seasonal ramp in backlog in Q3 and Q4, but we can also anticipate contract wins that will be revenue and earnings accretive in the remainder of the year. This is further supported by management's self-described "conservative" full year revenue guidance of between $400m and $450m.

1H 2014 revenue was approximately $190m. Expected revenue from backlog in 2H 2014 is $175m. Summing the two figures, I get current full year revenue of $365m. Thus, one can reasonably conclude management is expecting some fairly significant contract wins in the near term that will add to this year's earnings.

Valuation Update

I continue to see significant upside to purchasing shares at current prices. So let's walk through what a rational buyer might pay for the expected cash flow stream:

  • "Pro-Forma" EBITDA: Management is now guiding for full year revenue to be between $400m and $450m, as mentioned earlier. Assume revenues come in at $400m, the low end of the guided range. Apply a very conservative 13.5% EBITDA margin, and we arrive at expected EBITDA of $54m. This is on the high end of management's reaffirmed previous guidance of $45m to $55m, but still within range.
  • "Pro-Forma" Enterprise Value: The company has pro-forma debt of $150m from their recent note offering, which concluded after June 30, 2014. In the press release, management told shareholders that if the offering was done in 2Q 2014, cash would have increased by $34m. If we subtract out $30m for the anticipated equipment purchase that leaves us with a net increase in cash of $4m. Add that amount to reported cash of $13m as of 2Q 2014, we get "pro-forma" cash of $17m. Therefore, net debt is approximately $133m, and total enterprise value is approximately $257m.

At an enterprise value of $257m and pro-forma EBITDA of $54m, we get an EV/EBITDA multiple close to 4.8x.

I continue to believe a rational buyer would pay an average multiple of 7x EBITDA for this business. Applying 7x to this year's estimated EBITDA, we get an enterprise value of $378. Back out net debt of approximately $133m, and we get an equity value of $245m. At today's prices, one can purchase the business for a mere $124m, implying upside of approximately 100% in what I would consider a base case scenario. Earlier I estimated an upside scenario of around 70%, so the risk/reward profile has improved substantially.

Other Notables

There are a couple of catalysts on the near horizon that have the potential to unlock some of this value for shareholders.

First, the company will be reporting next quarter's results against what was a catastrophic 3Q in 2013. For investors fixated on sexy headlines, the next quarter's earnings press release should not disappoint. Furthermore, it will prove to those who are still hesitant that the third quarter of last year was indeed a one-time event, and not a permanent impairment to the business. Any trailing twelve-month statistic will be refreshed to reflect as much.

Second, it is all but assured that the company will announce contract wins in late 3Q 2014 and early 4Q 2014. Brent Whiteley's comments during the Question and Answer portion of the recent earnings conference call pointed out the natural seasonality to backlog, and those comments should not be overlooked. Here's what was said:

So, second quarter usually low point as far as building backlog where you have customers coming from winter season prepared within the year, we definitely see a building of backlog for the winter season in North America for its third and fourth quarter. And really the same in other regions you get through a - as customers start dealing with rainy seasons and all that in South America they start to contracting for the seasons over. So we really see a ramp up through the end of the year of our backlog and we expect the same result this year.

Conclusion

SAEX Holdings remains a low-risk high-uncertainty investment opportunity. I've found in the past that these characteristics in an investment tend to lead to favorable outcomes for investors in the long run. While I am unsure of when the market will assign a fair value to SAEX, when it does, I believe it will be close to 100% higher than current prices.

Disclosure: The author is long SAEX. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Acme Capital, LLC may buy or sell securities mentioned in this article for client accounts or for the accounts of principals at any time and without further notice. For a full accounting of Acme Capital’s holdings in any securities mentioned, contact Acme Capital at eric@acmecapco.com. Past performance is no guarantee of future results.